EEP 101/econ 125: Market for Ecosystem services (ES) David zilberman Deepak Rajagopal

Categories of Ecosystem Services (ES)

Source: Millennium Ecosystem Assessment (2005)

Provisioning Services

food, water, timber, fiber climate, floods, disease, waste soil formation, nutrient cycling, photosynthesis

Regulating Services

Supporting Services

Cultural Services

recreational, aesthetic and spiritual services

Market failure in ES

When beneficiaries of ecosystem services do not pay the managers of the ecosystem that generates these services, the market will under-provide such services or in other words over-exploit the ecosystem.

Policy mechanisms to address market failure

Incentive-based mechanisms
Tax, fees Subsidies Tradable permits

Direct regulation

Command and control, standard, bans

Public Provision Private contracts Voluntary agreement and educational program

Merits and Weaknesses for these approaches

Taxation and tradable permits are politically unattractive opposed by polluters Subsidy perverse incentives, expansion of polluting activity, imposes cost on nonbeneficiaries also, but politically better liked by polluters Direct control has no flexibility and is inefficient

Payment for Ecosystem Services

PES is A voluntary agreement between at least one seller (service provider) one buyer (service buyer) over a well-defined environmental service payment is conditional on delivery of service

Land owner

$$

$$$

Resorvoir in the midst of farm land City that draws water from resorvoir

Example 1 : Water cleanup

The New York water utility considered investing $2 billion in water filtering The water was contaminated by waste of 20000 cows that grazed in the water catchments of the citys reservoir The benefit per cow annually is $1000 It will cost $500 million to invest in in water quality if the cows will not graze. After negotiation with the local farmer each land owner will receive $1500 per cow/annually not to graze The lawyers received $50 million and staff was paid another $10 millin to reach a deal

Example 2 : Water cleanup II

If the rate of discount is 5%
Avoided cost due to PEM Minus Foregone benefits of grazing = (1000/.05)*20000 Minus Investment cost Minus Transaction cost $2,000,000,000 - $400,000,000 - $500,000,000 - $60,000,000 $1,040,000,00

Net Value of ES Benefits were shared

Cow owners gain = (1500/.05)*20,000 400 = $200M

Water users save = 2000 (500+60+600) = $840M

Example 2: Flood control by wetlands

Probabi Flood Expecte lity of damage d flood damage Without wetland 0.05 $10B $5B $1B $500M $100M $10M $50M $120M Cost of wetland Expected net damage $500M $150M $130M

Small 0.02 Wetland Big wetland .01

Maintaining a big wetland offers least expected net damage

Logic of PES
Deforestation and conversion to pasture Conservation Conservation with PES

Benefits to land users

Minimum Payment (WTA)

Payment

Costs to downstream populations and others

Reduced water service Biodiversity loss Carbon emission

Maximum Payment including transaction costs (WTP)

It is necessary that WTP taking into account transaction and other additional costs for long-term performance exceed the WTA

Who sells and who buys ES?

Service providers sellers and recipients of payments

Farmers, loggers, forest managers

Service buyers payers

Water users, farmers, electricity users, NGOs, government, etc.

Financing requirements
1. Set-up cost - Cost of designing the mechanism - Initial investment 2. Payment to service providers 3. Costs of running the mechanisms
1. 2.

Cost of collecting payments repeatedly Monitoring and enforcement

Financing PES
1. User-financed: When buyers are
actual users of ES 2. Government-financed (also includes International institutions) 3. NGO-financed: Nature conservancy etc. that rely on voluntary contributions In the last two mechanisms, buyers are acting on behalf of beneficiaries of ES

Who pays?
Service
Carbon Sequestration

Beneficiary
Global Community Countries and Businesses who want a low-cost way to reduce carbon emissions

Source of payments
UNFCCC Kyoto Clean Development Mechanism WB Biocarbon Fund

Watershed Protection

Local Community

Hydroelectric facilities Water user fees Irrigation association fees

Biodiversity Conservation

Global Community

NGOs GEF Biodiversity Offsets

National Initiatives (US)

The Conservation Reserve Program (CRP)

pays rents and cost-share assistance for long-term, land conversion from farming conservation

Environmental Quality Incentive Program (EQIP)

pays for adoption of conservation practices in livestock or agriculture. offers landowners the opportunity to protect, restore, and enhance wetlands on their property. provides financial and technical assistance to promote the conservation and improvement of soil, water, air, energy, plant and animal life, and other conservation purposes on Tribal and private working

The Wetlands Reserve Program (WRP)

Conservation security program (CSP)

US conservation program

CRP-Originated in soil conservation program

Initially targeted cheapest lands Now use an index based on mixture of attributes CRP $ 1.9 Billion EQIP $ 1.0 Billion CSP $ 0.2 Billion WRP $ 0.3 Billion Other $ 0.2 Billion

Spending in 2005

Payments are targeted to regions where there is political pressure not environmental need IS it a subsidy or a genuine program?

National Initiatives (outside US)

Courtesy: Stefano Pagiola, World Bank

Examples of PES (World bank funded projects)

Courtesy: Stefano Pagiola, World Bank

Why is PES attractive?

Generates its own financing (when userfinanced):

Brings new financing not previously available for conservation

Efficient:
Conserves what is worth conserving Does not conserves what is not worth conserving

Why is PES attractive?

Potentially very sustainable:

Not based on whims of donors, NGOs, but self-interest of service users and providers Need for water wont go away, so can generate indefinite payment stream

For this to work, need to:

Base payments to providers on payments by users Actually deliver services: getting the science right is critical Tailor mechanism to specific local conditions

How does PES compare to other policy instruments

PES vs tax

If ES service provide is too weak (poor farmers) or too strong (rich farmers) taxes may hurt or simply be infeasible

PES vs subsidy

Beneficiaries do not see the cost of their actions do not reduce demand PES offers flexibility and can be more efficient when there is heterogeneity

PES vs Direct control

 Consider 22 different farmers, A V Rank their potential private net returns from the new practices (in $/ha, in PV over a suitable time horizon) from smallest to highest Compare to the private net returns from current practices

$/ha

Current practices

B C D E

F G H

L M N O P Q R S

U V

Courtesy: Stefano Pagiola, World Bank, 2005

We can divide the farmers into three groups: Farmers Q-V have such high private returns theyll adopt the new practice with no support Farmers M-P have marginal private returns to adoption (eg because of high initial costs); so we may need to tip the balance Farmers A-L have such low private returns they wont adopt sustainably without on-going support

$/ha
Not privately profitable: Wont adopt sustainably Marginally profitable: May need to tip the balance Privately profitable: No need for support

Current practices

B C D E

F G H

L M N O P Q R S
Short-term payment will change land use

U V

Short-term payment may result in short-term adoption, but farmers will revert to current land use when payments end

Payment not needed

from Stefano Pagiola, World Bank, 2005

Now lets add the external benefits of the new land uses: Biodiversity benefits

$/ha
Biodiversity benefits

B C D E

F G H

L M N O P Q R S

U V

Courtesy: Stefano Pagiola, World Bank, 2005

Now lets add the external benefits of the new land uses: Carbon sequestration benefits (these depend on net biomass additions, so if everyone is implementing the same practice, they all get the same addition)

$/ha

Carbon sequestration benefits

B C D E

F G H

L M N O P Q R S

U V

Courtesy: Stefano Pagiola, World Bank, 2005

Now lets add the external benefits of the new land uses: Water benefits (these are often large, but only in very specific areas; elsewhere they are likely to be very small/zero)

$/ha

Water benefits

B C D E

F G H

L M N O P Q R S

U V

Courtesy: Stefano Pagiola, World Bank, 2005

Adding all external benefits of the new land uses:

$/ha
Biodiversity benefits Carbon sequestration benefits Water benefits

Current practices

B C D E

F G H

L M N O P Q R S

U V

Courtesy: Stefano Pagiola, World Bank, 2005

Bundling payments
Payments for more than one service may be bundled
Advantages:
Reduction in transaction costs

Disadvantages:
Distribution of environmental services over locations is not even

PES and distributional objectives

PES and distributional objectives Agencies aim to use PES as new policy achieving
distributional goals

However achieving multiple goals such as improving environment and distributional objectives using one tool may be difficult (Tinbergen 1956)

Impacts depend on correlation between environmental benefits and wealth (Wu et. al. 2001)

PES and Poverty

The poor can be categorized into 3 main groups: 1. Poor landusers who can supply environmental services. 2. Poor landless who supply labor. 3. Poor consumers who purchase food.

Focus here is on group 1, but important not to forget 2 and 3.

When will poor benefit from ES supply?

Land quality and location of the poor:

1) Are the poor located on lands of poor quality for agriculture but good for ES? 2) Can ES be an way of overcoming production problems in the farming systems of the poor?

Impacts depend on correlation between environmental benefits of land and wealth ES benefits $/ha
Agricultural benefits

B C D E

F G H

L M N O P Q R S

U V

POOR

LAND QUALITY

HIGH

If poor farmers own land with high ES value they may gain

Impacts on labor and consumers

If conservation program reduce employment poor land owner may gainbut ( landless) workers may lose If PES takes land out of production higher food prices may hit the poor Working land program where farming (forestry) continues but farmers are paid for green activities are better for the poor than land diversion programs

Examples of PES programs involving the poor

Location

Service
Carbon sequestration, biodiversity conservation, watershed protection Soil carbon sequestration, watershed protection Soil carbon sequestration

How Provided
Farmers plant trees, fodder shrubs, live fences

Purchaser
LEAD and GEF

Price Paid
For a 15 ha fazenda ~ US$2 a day

Central America

China

Forests and grasses planted (converted farmland or wasteland) Composting, no till, planting nitrogen fixing F. Albida, organic fertilizer Conversion from swidden agriculture to agroforestry

Central Government

US$36/ha per year

The Sahel, Senegal

Mexico

Forest carbon sequestration

International Federation of Automobiles

US$10/tC to US$12t/C

Summary

What is ES and why PES? Who pays and how? Examples of PES Potential benefits of PES PES and Poverty reduction goals Next class: From Theory to Practice
Nut and bolts of designing a PES Lessons from past experience

Selected readings

Millennium Ecosystem Assessment (2005) http://www.millenniumassessment.org/en/index.aspx Stefanie Engela, Stefano Pagiola, Sven Wunder: Designing payments for environmental services in theory and practice: An overview of the issues, Ecological Economics, Vol 6, Number 5, 2008

B. Kelsey Jack, Carolyn Kousky, and Katharine R. E. Sims Designing payments for ecosystem services Lessons from previous experience with incentive-based mechanisms, PNAS July 2008
Randy Stringer, Leslie Lipper, Takumi Sakuyama, and David Zilberman: Payment for Environmental Services in Agricultural Landscapes: Economic Policies and Poverty Reduction in Developing Countries. See Chapter , Introduction and Overview Sven Wunder: Payments for environmental services: Some nuts and bolts, CIFOR Occasional Paper No. 42

From theory to practice

Courtesy: Stefano Pagiola, World Bank